6 big-bank stocks with the best prospects

Analysts are on the fence for most banks — here are the exceptions

Earnings season for the big U.S. banks is here, and there’s bound to be a lot of ugliness when they release results for the second quarter: sluggish trading volume, thinning margins and limp mortgage banking.

But the banks with this year’s best stock performances — including Wells Fargo & Co.
WFC, -1.69%
which reported financial results today — don’t need to show stellar earnings growth now. They just need to bring home above-average returns on equity for shareholders.

Wells Fargo’s results set the scene for the industry. The bank posted second-quarter earnings per share of $1.01, compared with 98 cents a year earlier, meeting the consensus estimate of analysts polled by FactSet. Revenue fell 1% to $21.07 billion, beating expectations of $20.76 billion. The net interest margin continued to narrow, to 3.15% from 3.20% the previous quarter and 3.47% a year earlier. Return on equity was solid, at 13.40%.

J. P. Morgan Chase & Co.
JPM, -1.56%
Citigroup Inc.
C, -1.64%
and Goldman Sachs Group Inc.
GS, -1.86%
will release results next week. Where do bank analysts stand? Among large-cap financial companies, here are six that more than half of analysts rate “buy” (or the equivalent), according to FactSet:

The sole bank among these six expected to show year-over-year revenue growth is Discover, but analysts expect four of the six to produce sequential revenue improvements:

Here’s more on each of the six banks with majority “buy” recommendations from brokers:

Discover

Discover Financial Services is the best stock performer this year among the six banks listed here, as the company consistently achieves returns on common equity in excess of 20%.

There’s a built-in advantage for credit-card lenders — much higher interest-rate spreads. And during the aftermath of the credit crisis, it became clear that consumers had much more love for their credit cards than they did for the underwater homes they kept walking away from.

Without a positive earnings surprise, Discover could see its shares pull back when it announces its second-quarter results July 22, since the stock has been so strong this year. But despite the runup, the shares are still cheaply valued at 11.3 times the consensus 2015 EPS estimate of $5.58.

The consensus 12-month price target for the shares, among analysts polled by FactSet, is $66.65, implying growth of only 6%. But 12 months isn’t a very long period for a truly long-term investment.

J.P. Morgan Chase

J.P. Morgan Chase has certainly taken its lumps over the past year, with several major settlements that included a seemingly endless series of leaks by government authorities. Those included the $13 billion mortgage-backed securities settlement in November and $2.6 billion in settlements in January over the bank’s role in helping enable Bernard Madoff’s Ponzi scheme.

The stock trades for just 9.5 times the consensus 2015 EPS estimate of $5.92, and the consensus price target for the shares is $64.13, implying upside of 14%.

The bank’s regulatory headaches seem to have settled down, although there could be some more trouble ahead as multiple LIBOR and foreign-exchange investigations continue. The worst recent news concerns the health of CEO James Dimon, who last week said he would begin eight weeks of treatment for throat cancer

When the bank reports its results July 15, Jefferies analyst Ken Usdin expects a 20% year-over-year decline in trading revenue, in line with what the largest banks experienced during the first quarter. The analyst, who rates J.P. Morgan a “buy” with a $65 price target, expects the company to report a “modest” increase in net interest income and to provide an updated outlook on its efforts to contain expenses.

Capital One

Investors want to see Capital One return to growing its credit-card balances, which have been declining since the company completed its acquisitions of ING Direct and HSBC’s U.S. credit-card portfolio in 2012.

But it probably didn’t happen during the second quarter, since Capital One reported average credit-card loans held for investment during May of $69.2 billion, down nearly 1% from a year earlier.

On a more positive note, Capital One managed to boost its commercial loan portfolio by 8% year-over-year to $45.4 billion, as of March 31.

The consensus price target for the stock is $57.54, implying 21% upside over the next 12 months.

Citigroup

After suffering an embarrassing $400 million loss, in which Mexican subsidiary Banamex didn’t verify the existence of receivables collateral pledged by Oceanografia S.A. de C.V. (”OSA”), Citigroup CEO Michael Corbat said the company had begun a “rapid review” of similar programs for all subsidiaries.

Another humiliation for Citi was the Federal Reserve’s rejection in March of the bank’s 2014 capital plan. That was an especially bitter event for investors, because Citi is strongly capitalized, with a Basel III Tier 1 common equity ratio of 10.4% as of March 31. Investors who have seen the stock give up 87% of its value over the past 10 years were looking forward to dividends and share buybacks.

Well, there’s always next year. Meanwhile, Citigroup is unique among large-cap U.S. banks in deriving most of its revenues and earnings from outside the United States.

And Citi trades for just 8.8 times the consensus 2015 EPS estimate of $5.38. That’s the cheapest forward P/E for any large-cap bank stock.

The consensus price target for Citigroup’s stock is $51.14, implying growth of 14% over the next year.

CIT Group

Still, the stock has been the weakest performer this year among the six discussed here. Disappointed investors sent the shares down 6% on April 29 after the commercial lender reported first-quarter EPS of 56 cents, down 31% from a year earlier. The culprit was an 88% increase in the quarterly provision for credit losses to $36.7 million, which ran counter to the industry trend.

But most analysts recommend buying the shares, with a consensus price target of $51.14 implying upside of 13%.

CIT Group had $48.6 billion in total assets as of March 31, putting it close to the $50 billion threshold for banks subject to the Federal Reserve’s annual stress tests for the largest banks. Several analysts commented after the company’s Investor Day presentation in June that it was looking to make a major acquisition.

Janney Capital Markets analyst Sameer Gokhale on June 26 told clients that unless the Fed were to raise its stress-test threshold to $100 billion, he thought CIT Group would “find it difficult to unlock the substantial amount of excess capital currently on its balance sheet,” unless it made a big acquisition or sold itself.

“Although it is unclear which path CIT will choose, we believe either scenario should generate significant value for shareholders,” Gokhale added. He rates the shares a “buy,” with a fair value estimate of $57.

Morgan Stanley

The last big bank on the list is Morgan Stanley
MS, -2.00%
with just over half of analysts recommending investors buy the stock, which has a consensus price target of $34.50, implying 8% upside.

The bank is one of only two listed here for which analysts expect second-quarter earnings to improve from a year earlier. The bank bucked the first-quarter industry trend, showing year-over-year revenue growth in all of its operating segments, but analysts pointed out that the bar was pretty low, because of unusually weak results during the first quarter of 2013.

Philip
van Doorn

Philip van Doorn covers various investment and industry topics. He has previously worked as a senior analyst at TheStreet.com. He also has experience in community banking and as a credit analyst at the Federal Home Loan Bank of New York.

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Philip
van Doorn

Philip van Doorn covers various investment and industry topics. He has previously worked as a senior analyst at TheStreet.com. He also has experience in community banking and as a credit analyst at the Federal Home Loan Bank of New York.

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